Private equity reach into leverage loans to rise-S&P

NEW YORK, Aug 18 (Reuters) - Private equity firms are expected to expand their foray into leveraged loans and other distressed securities to capitalize on opportunities created by the credit crisis, Standard & Poor's said in a report.

The trend is expected to benefit banks as they continue to whittle down the backlog of unsold loans from the last leveraged buyout boom before the onset of the credit crisis in the summer of 2007.

Leveraged loan volume on bank books dropped to $45 billion in July from $237 billion a year ago and private equity firms were responsible for up to $30 billion of this reduction, S&P said.

Thirteen private equity firms were active in loan management during the first half of 2008 compared with 11 in 2007 and nine in 2006. Their share of primary and secondary sales has risen to 32 percent, Standard & Poor's said.

This "constitutes a new frontier in their investment strategy and is motivated by their search to put ample funds to work and maximize returns in an environment where opportunities for more conventional buyout activity are highly limited," the report said.

Leveraged buyout volume in the first half of 2008 was down 63 percent from a year ago because the credit crisis has made financing more expensive and investors more risk averse.

In a leveraged buyout, a sponsor takes a company private and finances the acquisition with debt. A private equity firm makes money by cutting costs at the company it buys and then using the increased cash flow to pay off debt.

Now these sponsors are buying the debt of the companies they took private, often at deep discounts and with leverage provided by banks that are eager to get rid of these loans on their balance sheets.

"Banks are among the intended beneficiaries of the increased presence of alternative players as buyers of leveraged finance," S&P said.

As prices drop in other asset classes, private equity sponsors could wade into less senior parts of the capital structure, such as high-yield bonds, mezzanine debt and even securitized debt, S&P said.

Recent examples include a Merrill Lynch MER.N deal to sell $30.6 billion of repackaged debt known as collateralized debt obligations, or CDOs, to buyout firm Lone Star Funds, for about 22 cents on the dollar.

UBS (UBSN.VX) sold $22 billion of mortgage debt to a fund managed by BlackRock Inc (BLK.N) at a 32 percent discount, and Lehman Brothers LEH.N was reported to be in talks for a potential sale of its portfolio of real estate and mortgage-backed securities. For details, see [ID:nN15291049].

Private equity firms have also emerged as a source for new collateralized loan obligation (CLO) vehicles, S&P said. The share of CLO issuance by private equity-related entities jumped to 22 percent so far this year, compared with 9 percent in 2007 and 7 percent in 2006. (Reporting by Anastasija Johnson; Editing by Jonathan Oatis)